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AOL, Microsoft Vie To Win Net2Phone

Massive amounts of money, bruised egos and the desire to weaken AT&T's core business - the Net2Phone story has it all.America Online and Microsoft elbowed each other to woo the Internet-based telephone service provider over the course of last week, Inter@ctive Week has learned.
Written by Max Smetannikov, Contributor

Massive amounts of money, bruised egos and the desire to weaken AT&T's core business - the Net2Phone story has it all.

America Online and Microsoft elbowed each other to woo the Internet-based telephone service provider over the course of last week, Inter@ctive Week has learned. But while AOL lawyers were sitting in Net2Phone offices in Hackensack, N.J., until midnight on several occasions, Microsoft barely got its wingtips in the door.

"Mr. Jonas hung up on Mr. Gates," said one person familiar with the Net2Phone negotiations, referring to Howard Jonas, president of IDT, Net2Phone's parent company, and Bill Gates, chairman of Microsoft. "Microsoft is very used to getting what it wants, but there is just not enough interest around here to work with them," said the source, who wished not to be identified.

A Microsoft spokeswoman refused to discuss the topic of the company's interest in Net2Phone. AOL, Net2Phone and IDT spokespeople also refused to comment.

At press time, sources close to the AOL-Net2Phone negotiations said the last issue on the table is money, but the desire to make the deal happen was strong. AOL is rumored to have offered $70 per share, or $3.6 billion for the company. Net2Phone's market capitalization currently stands at $2.7 billion.

Why the big interest in the small - and some might say overvalued - company? Its Internet Protocol (IP) telephony platform is a crucial missing piece for both companies, industry experts said.

According to Hilary Mine, senior vice president of research at Probe Research, Net2Phone is so hotly contested because it has end-user software that is reasonably successful. And the next big application to hit the consumer Internet market is voice.

"We are looking at the holy war between AOL and Microsoft," Mine said. "AOL and Microsoft are in the war for the end user - via networks and via software."

Microsoft has also been making strategic investments in broadband, with $1 billion going to Comcast and $500 million to AT&T. On the software side, a voice-over-IP (VoIP) feature could easily be added to Windows, Internet Explorer or even NetMeeting.

That said, Net2Phone would be a nice fit for AOL, analysts said.

"The Net2phone acquisition, were it to take place, would enable AOL to provide voice phone calls to the Internet - which makes perfect sense if they want to become a next-generation communications provider," said John Cha, industry analyst for packet telephony and voice/data convergence at Frost & Sullivan. "With AOL's recent cable acquisition they would then be able to provide broadband as well as Internet telephony."

It is yet to be seen what the competitive onslaught of AOL or Microsoft would do to long-distance and international telephone rates, but one thing is certain: The company hit the hardest by VoIP telephony would be AT&T.

With its acquisition of Tele-Communications Inc., AT&T has mortgaged its telephone revenue to build out a broadband network of the future that would give customers voice, video and Internet access over a single pipe. That one-pipe strategy might backfire now, since users, hooked on AOL services such as instant messaging, Netscape and e-mail, could begin making dirt-cheap phone calls over the Internet, with videoconferencing not far behind.

Also, AOL, with its Time Warner acquisition, still has a choice of Digital Subscriber Line and cable modem lines and sits on a mountain of premier content. All in all, Chief Executive Steve Case's AOL could have the pipes, customers and services to eat into AT&T's revenue through fair-and-square competition, industry experts said.

AT&T officials declined to comment.

Net2Phone, 5.3 percent of which is already owned by AOL, has 500,000 customers using the service at least six times per month. The company routes 1 million minutes per day through 40 countries on its VoIP network - in part supported by AT&T, incidentally. Ultimately, a Net2Phone button would be integrated into AOL's ICQ instant messaging system and its popular Netscape browser, opening the service up to millions of new customers.

The combination of broadband capacity, large installed consumer base and Internet telephony is the ultimate mix that could finally make Internet telephony companies viable competitors to telephone companies, industry players said. VoIP companies cheered the news of competitive negotiations at Net2Phone headquarters, pointing out that these developments bear out what ventures such as Princeton, N.J.-based ITXC have preached all along.

"Provisioning voice services could turn service providers into virtual local exchange carriers - if you think of baby Bells doing local calls, the same logic applies to Web sites that now will be able to originate calls. So your portal will become your telephone company," said Tom Shoemaker, executive vice president of business development at ITXC.

But even without a deal, Net2Phone is an undefeated VoIP leader. Of the 1999 market of 1.7 billion minutes and $263 million, Net2Phone had 27.1 percent, according to Frost & Sullivan. Not to say the company is making money - it has been in the red since day one, achieving a deficit of $30.5 million as of July 31, 1999, according to Securities and Exchange Commission filings.

Such details are insignificant for profitable AOL, which needs the technology platform. If the deal happens, AT&T has good reason to worry.

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